All men’s miseries derive from not being able to sit in a quiet room alone. – Blaise Pascal

Posted by: donmihaihai | January 20, 2008

Celestial back to hell.

Celestial was sent back to ground in the last 1 year plus or so but hell is where Celestial is right now as share price drop from >$1 to $0.665. At one time it went down to $0.56, the lowest after the bull market for China-listed stock started. Is there any good reason for this slump? Many investors may like to ask. But I don’t like to ask this question or actively searching for answer because if there are anything reasons out there and not announced by the company, I will be the last one to know.

Anyway Celestial is cheap. How cheap? Consider this.

No. of issued ordinary shares : 636,473,380

Share price : $0.665 and $0.56(lowest recorded for this slump)

Market Capitalisation : $423 million ($0.665). $356 million ($0.56)

NPAT for 2006 was $73 million, P/E : 5.8 X($0.665) . 4.9X($0.56)

BV at 3Q2007 was $318 million. P/BV : 1.33 X ($0.665) . 1.1 X($0.56)

At the 1st look, Celestial is currently trading at an extremely cheap valuation but this calculation is incomplete as Celestial have issued convertible bonds which can be convert to 91, 437, 688 ordinary shares at Jun 2011 and outstanding share options of 7,600,000 which can be exercise at $0.30. Share options will be exercise as the exercise price is way below current price so 7,600,000 shares must take into consideration. Convertible bonds are another story as it is 3 years down the road with 2 outcomes. Here is the interesting part.

From the simple calculation, Celestial is currently trading at 3 to just over 5 X 2006 earnings. Just by this alone, the market is assuming after generating $73 NPAT in 2006, increasing NPAT since 2000 and throwing out yearly increasing cashflow since 2002, Celestial is unable to generate at least $386 million for its remaining life. Is it possible? Even if Celestial is selling commodity products it is still very safe to say cheap. Celestial is very heavy and fat even if I get the intrinsic value totally wrong.

I have separate Celestial businesses into 2 units which is retail consumer products and industrial products for easy assessment. Very soon a third unit will be add on. And the main raw material is soybean and with the commodities price surging upward, soybean is not spare especially 4Q2007 which is like going up in a vertical straight line. Bad news but this is not something new as Soybean price had gone up about 4X in the last five years. Every industry dealing with soybean as raw material has to bear with it so 1st time is if raw material going to kill Celestial, every company in this industry will be dead too and not just in China but globally. Which mean products from soybean are irrelevant to our consumption? It is not as if the high soybean price only happen in 4Q2007 so the thing is Celestial handled the increased of raw material beautifully due to well ever increasing demand from the Chinese. What about the Chinese government trying to control price due to high food inflation? That does not sound good if Celestial products are included in the list but Celestial products are not those consider basic needs. Think longer term, unless government want to shut down this industry, this will pass. The one to get hurt is actually going to be biodiesel.

The retail products are actually the most exciting part of Celestial but it is not as exciting as in the past where most of Celestial revenues come from this segment. As of now it make up of about 50% of the revenues. Celestial try to put a name on their product and try to make a branding out of it. The power of branding and return generate from this can be extremely high by looking at other developed countries and developed brands. Will “Sun Moon Star” become one of these brands? I don’t know but as far as what I know and what I see in order to become one these brand, 1st of all is not to be mis managed not just in the branding side but financial and operation side as well. Like many other brands out there in China, Celestial stands a chance to make it. After holding on since 2000, every additional year increase the chance that Celestial can make it and benefits from it.

After wondering around and spending huge amount of capital in the industrial products, 2007 is a turning point where Celestial announced new plans with new retail products. It is a big welcome even thou the success of these new products is unknown. Well, not ever new product will be a success. The market in China is big and with huge potential so I certainly agree to try out new products. With their facility utilisation for proteins powers running at close to 100%, it is a good time to see if the management is shifting back their focus to retail products.

As for their industrial products, there is actually nothing much to say where these are mainly commodities product which also mean unlikely to generate high return out of it in the long run. Currently, this segment look ok or even great as the underline reason should be demand is strong. Since Celestial build this segment as an integrated part of the whole business, one has to accept that a big part of the revenue will be from this segment. Something positive is Celestial keep increasing the range of products which mean it won’t be hold ransom by any overproduction of a single product. And if Celestial wants to be in this segment, it must increase the scale and range of products to possible achieve better return out of it. But it is not easy and the time, energy and capital requirement is not insignificant at all.

Biodiesel is the last segment. I totally dislike it which one the reason that I sold a chuck of Celestial back in 2006 the next day after the announcement of this project. With all kind of news, data and other examples elsewhere, it is unlikely going to be profitable for Celestial. The logical step is to write off this segment which includes all fixed assets and working capital. A quick look at the total investment in this segment announced by then with Celestial share stand at RMB421 million. Capital expenditure of around RMB300 to RMB400 was spent as the project is almost completed. It doesn’t matter when these write off appear in the financial statements. This money already throws away so it won’t cause any trouble to the cashflow anymore. What left are working capital and general expenses. How much money Celestial will potential lose here depend on how long Celestial going to operate this segment. With the returns generated since Celestial started, it is unlikely(I hope) that the same management will operate a losing unit for long.

Unless I am wrong and it is going to be profitable and generating better ROI than just plain soybean oil, I would rather focus on more important things like why the management is going into biodiesel, looking at what the management says, what the number show, etc. Because it will provide insights for what more to come in the future.

End of the day, it still goes back to one main questions, will Celestial able to generate more than $386 million cashflow in the future or Celestial D day is really near. To me, the retail segment with longest record available is easily worth more than $386 million alone.

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Responses

Thanx very much for your detailed research. My problem is, I do not get the point. Why is it all up to the question that Celestail needs to generate 386 Million cashflow in order to survive? thank you for pushing me a bit further

I did not write a detail research. This was written out of a moment when I see Celestial valuation keep dropping.. like toward hell. I feel very disappointed if it is being use solely or being a big part of the reason whether to invest in Celestial or not.

As for the 386 million, 1st of all I use NPAT rather than cashflow which come to $73 million NPAT in 2006 because of the timing as 2 of their past major expansions started toward the end of the year which distorted cashflow. 2007 cashflow showed a better picture.

Next I did not say Celestial need to generate 386 million to survive. I am questioning the valuation of Celestial which stands at $386 million(EPS X total outstanding shares) at $0.665. Investment apart from speculating, the future return depend on how much we put in, which also mean that if going forward(many years until the D day for Celestial), if Celestial cannot generate profit which add up to a reasonable return from $386 million(reinvestment for maintain and expansion is exclude for simplicity) then Celestial is actually expensive. The amount of money can be easily to use for other investment.

It may sound abit strange because the common valuation methods usually focus on at what level of PE or PB ratio. But I like simple thing which lead me to question myself. Would I pay $386 million for 100% of Celestial which cannot be actively sell off(stock market or buyer) to get Celestial potential future earnings?

my initial concern was the same as yours as with not agreeing the biodeisel part.. my stand is because soy beans are actually the worst commodity used to produce biofuel as the yield to it is relatively low as compared to others like palm oil…

however.. i remember reading from somewhere that it is a JV with some other company.. to process the soy bean oil which is a by-product (meaning they hv got no use for it)… this may be a good move to sell the by-product and make money from it instead of just throwing it away…

i’m unable to find that particular evidence (in the form of statement from the co) in supporting what i said above.. but it will be good to verify..

The evidences are there since day one in the announcement of JV and many more. As I had put it in the last part of my writing, unless biodiesel can generate better ROI than soy oil, if not all the talks about going into biodiesel to turn by-products into biodiesel is rubbish. Having higher revenues and bigger facilities does not = to higher return.

Secondly, I know this was written a year ago now, and you have turned more negative on Celestial since then; however a few throughts/questions:

On looking at this you had missed the fine print of the bond wording where the convertible bondholders had the right to redeem early at their option namely by June 2009. This is now a huge problem for Celestial, as $274M will need to be repaid and from a quick look at the 3Q 08 presentation Celestial has net cash of only $40M. I will be checking further, but am I wrong in these figures?

So it looks as if Celestial are going to have to obtain a loan from elsewhere, (as indeed the company has indicated)at more or less the worst time to be looking for a loan.

When the company went into its soybean zone project, it did not have the requisite funding, but went ahead anyway and obtained the funding at a good rate from the local government. However that took a long while; so this is a high risk entrepreneurial company in my opinion, seeing that it is back in the same position now – except that the position is worse in some ways as the credit environment is terrible and there is a definite time limit (June) for obtaining the funds.

Perhaps this very aggressive approach is the right way to do business in China, but it can give investors heart attacks along the way. If Celestial defaults on its redemption repayment requirements, presumably its reputation will be irredeemably tarnished, it will face law suits and perhaps it would go out of business altogether.

I am guessing very speculatively that perhaps there is a 70% chance that Celestial can obtain funding (-after all, it previously obtained funding from the local Government, who want to encourage industries other than oil), perhaps there is a 20% chance that Celestial has to resort to dilutive rights offer measures, and say perhaps a 10% chance that it will go under.

Do you keep on holding a stock like this which is, frankly, a gamble on finance being arranged?

Anyway, as Celestial share price is so depressed last few weeks (23 cents as at this afternoon), do you think it is a good time to acculumulate?

What I understand that they should not have any problem in case the convertible bond is going to be fully redeemed. In their 3Q results, we see that they are holding around 270m$ cash & equivalent. I am not sure where did hoegaandit find the news that they only have 40m. Do let me know if I am wrong.

Apart of that, they will still have 6 months before the redemption and in my opinion, based on their current cash flow generated from operation, i more convinced that there should not be an issue for the early redemption. Do you agree? The best is that they can find other source of financing for the redemption.

Don’t you have confident in yourself? If not why doubt yourself when someone from the net who never read the financial statement say you are wrong? Then you ask another strange guy hiding somewhere behind the net whether you are right?

Just take a look back 3Q2008 presentation show cash RMB1397.4M and debt RMB1215.5M. Net cash of RMB181.9M.

But since that total debt represent all convertiable bond commitment, there is no issue at all. After generating RMB163M and Capex of RMB749M, Celestial is currently in net debt position of RMB414M at 31/12/08.

With Celestial cashflow, debt refinancing is not worring me at all.

Is Celestial a high risk entrepreneurial company? Yes and no for me
Yes : Always seeking for growth and huge expansion project.
No : Superb cashflow. Something that is so valuable and reached a sizable amount that able to fund “pet projects”

I agreed that when Soybean zone project was out, there were worries about funding and the success of the project.

But there is one very important point that wasn’t being take into consideration back then by many which was Celestial consumer F&B products. Utilisation was high and demand was good that Celestial was choosing which products to produce and an expansion of facility(>2x) was coming online soon. Celestial Cashflow without that expansion was almost RMB100m and 65.8% of FY2008 GP was still contributed by Health F&B by the same facility.

At that time before health F&B coming online, it can be say of a gamble that even if Soybean project is not going to be a success, it won’t get bombed. After the results of F&B expansion, it become crystal clear that cashflow was so strong that the success of Soybean Zone project is not critical at all.

Celestial had already repaid all funding of Soybean Zone project by superb cashflow. Proceeds from convertibale bond was never being used until the latest “pet projects for F&B”. And Celestial was never really into debt for last few year if CB was taken out.

I apologise for not having the time to verify this insofar possible (-the Celestial announcements site is not working properly on several computers I have tried). However if I understand it correctly, Celestial needs to obtain finance outside of China by June to enable repayment. Assuming so, it is not just a question of arranging lending, as funds borrowed in China cannot readily be remitted outside of China as required. Can Celestial obtain finance outside of China in this very difficult credit environment? It does not encourage confidence that this life or death issue was apparently left so late to be resolved, and further that the new CFO is only 34 years old and with no apparent experience from what I can tell outside the Chinese public sector. I think all this may explain the crazy shareprice.

“However if I understand it correctly, Celestial needs to obtain finance outside of China by June to enable repayment. Assuming so, it is not just a question of arranging lending, as funds borrowed in China cannot readily be remitted outside of China as required.”

While I know there is restriction on transferring of funds, I don’t know that it can’t be done. If it is true and if possible, please lead me to the source. Like to read it myself.

If that is the case, chances of CB owner taking over Celestial upright and shareholder lossing every cent is there. But the next question is can they force to shut down a prefectly healthy company.

But is that the case? While the credit tightness is unexpected but from Celestial 1H and 3Q2008 results announcement, preparation for CB already started. That mean Celestial went in with eye open, especially for Capex.

Apologies for late reply. It has taken me some time to obtain verification. Here is reply now received from Mr Sun Feng of Celestial IR:

“For early redemption, the bond will be paid by Singapore Dollar. and the financial team are working on the refinancing, when there is significant progress we will announce timely”.

My understanding is that there are significant problems with moving (nearly S$300M) funds from China to Singapore, if this can indeed be done. Does that not imply the refinancing needs to be done outside of China, obviously a very difficult task.

This confirmation received tends to make me quite a bit more pessimistic on Celestial, although it is noted that there are other examples out there of companies negotiating extensions/discounts on their CBs. After all, in a worst case scenario, surely the CB holders will not want to exercise their presumed rights to take over the business or assets of Celestial?

CB is a bond with added equity kicker. So it is bound by contract 1st and as long as the kicker is out of the pic. So whether paying Sing dollar or RMB is being stated in the contract. With that, paying back in Sing dollar is not a surprise or new.

I have been know the difficulity of moving money out of China by hearing, news, prospectus but up till now, no one really pointed out to the exact source — rule and regulaton. Of course I will appreciate if someone can point me to that source. And I know the China does not always play by the rules.

I have run scenario of “outcomes” from the point of views from both equity holders and CB holders and will put them down later…. need more free time to write. Even with the worse case scenario, the chances of Celestial worthing more than current price is very high. Time is Celestial best friend here.

“After signing an external loan agreement, the FIE should promptly register with SAFE the external debt on a periodic or per case basis before it can use the foreign exchange obtained. It should also report to SAFE upon actual utilisation of the foreign exchange. The borrower may repay external debts with its own foreign exchange or it may, with SAFE approval, purchase foreign exchange with renminbi to make repayment. All payment of principal and interest on external debts must be approved by SAFE (except in the case of banks)”.